International Trader - Asia

A Bright Play on China's Water Shortage

With 19% of the world's population and just 7% of its potable water, China must spend tens of billions of dollars on waste-water treatment facilities over the next five years. Good news for China Everbright International.

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China's environmental woes go well beyond Beijing's peerless smog. Its teeming cities dump more than 150 million tons of municipal solid waste each year. The accumulated heap—untreated and stacked willy-nilly—has swelled to six billion tons. Meanwhile, China has 19% of the planet's population but just 7% of its potable water, and the shortage is exacerbated by pollution.

That's good news for
China Everbright International
(ticker: 257.Hong Kong), the environmental unit of the vast state-owned China Everbright Holdings. The unit earns 69% of its revenue from building and running facilities that convert waste to energy, another 20% from treating waste water, and the rest from alternative-energy projects. All are priorities for the new Communist leadership taking office this fall.

Beijing, of course, has more pressing problems right now. President-to-be Xi Jinping has abruptly called off a string of public appearances, fanning speculation of illness or accident. Chastened Western demand has hurt exports and idled factories, and Chinese stocks recently plumbed three-year depths. Yet none of these should detract from Beijing's longer-term environmental agenda.

After all, Beijing desperately wants to encourage urbanization, improve its people's standard of living, and encourage more consumer spending. "Without investing in waste treatment and water infrastructure, that vision cannot be realized," says Ian Simm, a London-based co-portfolio manager of the Pax World Global Environmental Markets Fund. He calls this "one of the more robust areas of China's development," and one that's quite independent of Asia's economic cycle.

Beijing's latest five-year plan, for example, aims to raise the rate of waste treatment to 90% from 78% in cities, and to 70% from 27% in more rural counties. This requires earth's most populous nation to invest 264 billion yuan (about US$42 billion) between 2011 and 2015 on waste treatment, five times more than what it spent between 2006 and 2010.

Such commitment bodes well for China Everbright, which holds a leading 7.1% share of China's young, highly fragmented waste-to-energy market. Last month, the company raised 1.24 billion Hong Kong dollars ($160 million) by selling 350 million new shares, or 8.7% of its total share count. Further stock sales—and dilution—can't be ruled out, but the latest issuance should cut the debt-to-equity ratio to 27.5% from 50.2% and cover construction expenses through late 2013. This year's robust new-projects roster already counts one hazardous landfill and eight waste-to-energy contracts, and DBS analyst Patricia Yeung expects the strengthened balance sheet to spur more deals before year end.

A backlog of orders further "gives reasonable visibility to earnings growth of about 30% in 2012 and 15% in 2013," adds Simon Gottelier, an investment manager with the Pax fund. China Everbright also meets other criteria the fund likes: A state-owned parent can help procure cheap financing and has a leg up when jockeying for government projects. "Build-Operate-Transfer" contracts to build facilities, operate them for a franchise period—typically decades—before transferring ownership to the government further ensure a steady stream of revenue.

China Everbright shares are up 36% this year, three times better than Hong Kong's Hang Seng index; at HK$3.83, they fetch 14 times 2012 profits. That's below the 16.5 times commanded by global peers, even though there's a lot more to clean up in China.

ASIA'S SLUMPING MARKETS rebounded as the U.S. central bank outlined measures to prop up the economy. The Nikkei jumped 3.2% for its fourth gain in six weeks, while Hong Kong, South Korea, and India all climbed more than 4% last week. But don't expect Asian central banks to follow suit. Political pressure on the Bank of Japan to goose its economy more aggressively "is on hold, due to leadership battles in the political parties," notes Robert Feldman, chief economist at Morgan Stanley MUFG in Tokyo.

In India, core inflation rose 5.6% year-over-year in August, up from July's 5.4% rate. While food inflation retreated slightly, it's still high at 9.1%, and Leif Eskesen, HSBC's chief economist for India, thinks "lingering inflation risks" will keep the Indian central bank on hold this week.